Most Popular ArticlesAugust 4, 2009
Is recent bank profitability indicative of industry recovery, and how much of it is the direct result of government assistance?
Much of the profits are coming at taxpayer expense. Even if the government doesn’t end up taking large losses on the TARP, the government accepted a huge liability. We set up a situation where heads the banks win, tails the taxpayers looses. There is a huge implicit subsidy, and that’s what we’re seeing in bank profits right now.
Listen, I understand that when a house is burning down, you don’t argue over how you put out the fire; you just do it. But the quid pro quo--which should have been and still could be demanded--is much stiffer regulation. This is what happened in the 1930s when the government rescued the banking industry. The same thing should be happening now.
We made a huge gift to the banking sector, and we should expect something in return. We have a moral right. And this is not the end of the story, and there needs to be follow-up regulation that ensures that this meltdown never happens again. There is an administration proposal that addresses this matter. But as of this moment, there’s no actual bill pending.
Are we past the need for nationalizing some banks?
I don’t know. I had wanted temporary nationalization of the weakest banks. This would’ve cleaned up their balance sheets, recapitalized them, and enabled the taxpayer to share in the profits when they do recover. Whether we are truly past this need depends on whether bank profits are going beyond transitory gains, favorable changes in accounting standards, and reduced competition. It’s too early to know if these earnings are for real and sustainable over the next two years.
What are your thoughts on the Public-Private Investment Program?
So far, it has turned into kind of a joke. There’s just not much happening. The banks simply want to hold onto their assets for more than what people are willing to pay for them, even with the implicit subsidy the government is providing potential buyers.
Does that mean we should stop trying to clear the toxic assets off their balance sheets?
I don’t know what we should do about those assets. It’s always been hard for me to see how we get the banks to clear these troubled assets off their books without nationalizing them first. So I don’t think we will be getting anywhere soon on this particular front.
How can we control private sector leverage?
If we subject the shadow banking industry to regulation, then the incentives to over-lend would be greatly reduced. Look at the ratio of household debt to income. It was stable between the 1950s through the early 1980s. Then right after the big bank deregulation of 1982, we started to see this ratio climb sharply upwards. If we are serious about banking regulation, there will be less securitization, less subprime abuse, and less of the equivalent.
Where are we in the housing crisis?
Looking at price-rent ratios or price-income ratios, which indicated a bubble early on, we are likely near the bottom. But I think we will bounce along the bottom for a long, long time.
Should we ever again let another major financial institution like Lehman Brothers fail?
Experience says no. That’s why you need to regulate these institutions up the wazoo so that you can’t let them fail. But before that occurs, I would definitely be against letting another major institution like Lehman collapse. In fact, I was shocked when the government didn’t save Lehman.
What are the largest threats to the US and global economies?
I have three basic concerns. First, while the giant banks seem to have been stabilized, we may have a second smaller wave of financial crises focusing on smaller banks. They could be especially hard hit by declining commercial property activity and values. This can cause substantially greater credit problems. The residential mortgage market could take an additional hit from higher monthly payments coming from Option ARMs and Alt-A mortgages resetting.
But we now have a lot more implicit government guarantees in place, and it’s hard to imagine that the magnitude of losses could be as large as what we just experienced with subprime. But I don’t think European officials have fully recognized both the real and potential scale of continental property and bank losses.
Second, there’s a danger of the economy slipping back into recession if the recovery doesn’t gain traction. This is especially possible if unemployment continues to rise or remains high and if consumer spending continues to decline because people just don’t have the money. Anecdotally, just look at the proliferation of vacant storefronts. So I’m concerned if recovery hasn’t taken hold once the stimulus spending runs out, what then will happen? We’ll get a real sense of this by year’s end.
Third, this malaise may simply just drag on and on like the Japanese experience. I’m worried about wage deflation given that wage growth has virtually ended. A second stimulus package of say $400-500 billion would help sustain economic growth and avert the potential disastrous effects of deflation.
Can you give us a quick roundup of your macroeconomic projections for the next 12-24 months?
As I mentioned earlier, I see real GDP growth in the second half of this year and in 2010. But it will be modest, somewhere between one and three percent. This makes me less optimistic than the Fed. And I don’t think it will be enough to put much of a dent in unemployment.
Accordingly, the jobless rate will head higher. I agree with Goldman Sachs’ economists who think the unemployment will top out at 10.8 percent and then stay there for quite some time.
Huge federal deficits will continue over the next year or two, but then decline significantly. However, what happens beyond that depends on policy, such as what we end up doing with taxes and health care.
Will heavy demand for financing hurt the dollar? Hard to say. I don’t have a strong view on the greenback. Pressures on the currency are actually less than what they are perceived to be, in part because the US will likely emerge from recession earlier than most other developed market economies.
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